Can Tesla (TSLA) Profit From Its Insurance Business?

The Wealth Advisor Contributor

January 12, 2022

(Investopedia) - For most Tesla, Inc. (TSLA) investors, electric vehicle sales are the headline numbers on the company's balance sheet. But if CEO Elon Musk is to be believed, another part of Tesla's business could account for a significant chunk of its profits. During an October 2020 earnings call, Musk suggested that the company's insurance business, launched the previous year, could account for between 30% and 40% of the overall future value of its car business.

At Tesla's current $1 trillion-plus valuation, that means the insurance business could be worth as much as $300 billion to $400 billion in the coming years. To put those figures into context, the higher end of that estimate is equal to double the combined valuations of Tesla rivals Ford Motor Company (F) and General Motors Company (GM).

KEY TAKEAWAYS

Tesla's car insurance, which is available in three states currently, is expected to make major contributions to the company's bottom line in the future.
In its current form, however, the insurance product needs to overcome several problems to make a visible difference to revenues.
Tesla CEO Elon Musk has said that the insurance arm could be as big as 30% to 40% of the company's car business.

Tesla’s Car Insurance Business

With a worth of $288.4 billion and average annual growth rates of 2.7% in the past five years, auto insurance is an attractive industry.2 Tesla entered the business in 2019 in California as a broker for policies underwritten by State National Insurance Company.3 The company has expanded its operations since then, launching a similar product in Texas and Illinois. Tesla has also applied to offer insurance coverage to customers in Washington, and it launched an insurance broking firm in China in August 2020.

Apart from generating revenues for its business, providing auto insurance to customers helps the electric carmaker solve two problems at the same time.

First, it reduces the overall cost of insurance for Tesla vehicles. A 2018 USA Today survey ranked the Tesla Model S as the most expensive car for auto insurance.6 Insurance costs for the Model 3—Tesla’s mass-market vehicle—are also higher than the industry average.

Second, and this is related to the first, Tesla's insurance business could also boost sales of its cars by reducing the overall cost of ownership. The company has promised monthly premium discounts based on a driver's "safety score." The scores are calculated using "real-time driving behavior" monitoring that checks for actions such as aggressive turning, hard braking, and unsafe following distances. For example, drivers with "average" safety scores save between 20% to 40% on their insurance, while those with the highest safety scores can save between 30% to 60%.

Monitoring driver performance also serves another purpose for the carmaker. CEO Musk says that it enables a "much better feedback loop" that connects manufacturing processes with car design, meaning the company can make changes to its car design based on data collected about driver behavior. Robert Le, analyst at Pitchbook Mobility, says Tesla has "full access data" to vehicle features, such as battery levels, autopilot, and car lights.

To be sure, the concept of usage-based insurance, or UBI, is not new. Insurance companies like The Allstate Corporation (ALL) already offer similar products. Other car manufacturers like GM and BMW have their own versions of usage-based insurance that offer discounts to standard rates and are much bigger than Tesla's offering.

In such systems, a device that reviews driving behavior for a limited period is typically installed in vehicles. Discounts are offered based on assessments made during the review period as well as credit and type of vehicle. Tesla, on the other hand, claims that its insurance product does not take age, gender, or driving history into account.

Can Tesla Generate Profits from Its Insurance Business?

Tesla's insurance business is not expected to pose a major threat to incumbents in the insurance industry, at least initially. According to Tom Super, vice president of intelligence at J.D. Power, Tesla's entry will have a "limited impact on the average auto insurance consumer, including the premiums they pay."

More importantly, he says the success of Tesla's insurance venture depends on sales of its cars. That statement is not surprising. The auto insurance industry operates on low margins, and scale is necessary to derive profits from the business. The electric carmaker lags its more established counterparts by a wide margin in sales. In 2021, Tesla sold 936,172 vehicles, while GM had sales of 2.2 million cars during the same time period.

The initial feedback to Tesla's insurance product should also be cause for concern. While investors have given the product a thumbs up by pushing the company’s stock price higher, customers are a more difficult sell. Immediately after launch, the Tesla insurance registration site crashed, leading to complaints from those attempting to sign up for it.13 Commenters on a Reddit forum said their estimated rates from Tesla were higher than what they were already paying to established insurance companies.

Underwriters for Tesla’s insurance also have a spotty track record with customers: they have received higher-than-average customer complaints as compared to other insurers. There's also the fact that the company's driver monitoring systems, used in its Full Self-Driving (FSD) and Autopilot, are a work-in-progress. A Consumer Reports test last year found that GM's Cruise systems did a better job of monitoring drivers than those for Tesla.

But Tesla's vertically integrated supply chain may provide it with a long-term advantage in insurance. High insurance costs for its cars are a function of their production costs. Those costs are decreasing fast, as reflected in the company's increasing operating profits. The Tesla insurance product also expedites the claims process by providing a direct connection to the manufacturer and making it easier for vehicle owners to schedule maintenance and repair. This could generate a lock-in effect. As car sales increase in the coming years, Tesla owners will likely prefer company-offered insurance.

But that is in the future. Usage-based insurance is relatively uncharted territory. According to the National Association of Insurance Commissioners, there is much uncertainty regarding the selection and interpretation of driving data using UBI and pricing rates for premiums based on that data.

Analysts have a bullish take on Tesla insurance anyway. According to Morningstar's Seth Goldstein, the insurance business will generate a majority of sales and all profits from the services and other segments in the future.